If gold were generally
accepted as collateral in global monetary dealings, would we
see it used as such? Strangely enough –No! In certain transactions,
however, where no other collateral –whether currencies, government
bonds and the like—is used, gold may be used, as a last resort. There
has been a very long history of gold being sought as collateral, but only the
most desperate of debtors has allowed their gold to be used as such.
Government bonds are easier to produce and are limited only by market
confidence. Moreover they remain in the jurisdiction of the issuer, leaving
the issuer in control of them. Gold is different and can only be used once,
held outside of the owner’s jurisdiction. Control is therefore lost. It
cannot be printed and becomes a complete commitment by the owner to honor his
obligations.
So why is gold
as collateral such an important step for gold in the global monetary system?
The Latest Moves
Last week, the
European Parliament’s Committee on Economic and Monetary Affairs agreed
to allow central counterparties to accept gold as collateral. Once ratified,
we would see gold redefined as a highly liquid asset under the Capital
Requirements IV Directive, due in June from the European Commission. This is
not the first time gold has been accepted as collateral. Late in 2010 ICE
Clear Europe, a leading European derivatives clearing house became the first
clearing house in Europe to accept gold as collateral. In February of this
year JP Morgan became the first bank to accept gold bullion as collateral.
The Chicago Mercantile Exchange is now accepting gold as collateral for
certain trades and the London-based clearing house LCH Clearnet
has said it also plans to start accepting gold as collateral later this year
subject to regulatory approval.
Why now?
Despite
comforting words from the U.S. the Eurozone, government
debt is being regarded with somewhat less enthusiasm than in the past. Both
monetary zones are experiencing awful problems regarding their debt,
particularly on the international front. A look at the Mediterranean members
of the E.U. shows nations either unable to repay their debts or on the brink.
This makes their debt dubious collateral. The sight of the E.U. wanting to
control taxation –sell state owned assets on condition that more funds
are poured into the country—is really what happens when an individual
is liquidated (sequestrated). It’s nothing short of that. Will Greece
accept this without some dramatic moves? If Greece had lost a war, then this
is what the spoils would be. That is certainly how the Greek people will see
it.
Are debtor
obligations more important than national sovereignty?
The answer to
this big question is not as apparent as it seems….
If they are
at the very least social unrest is likely, which in turn will further damage
one of their main sources of revenues, tourism. But Greek voters are aware
(as much as their government is aware) that Greece retains jurisdiction over
Greek assets in Greece. It is their decision, not the E.U.’s.
Other
potential reactions may include…
v A refusal to accept anything but a 50%
write-off of debt and leave the banks to sort themselves out.
v Leave the E.U. with the obligations
unmet or a massive extension to the maturity dates made by the Greek
government.
v The reinstatement of the Drachma and
make holidays in Greece very cheap, as inflation takes off, euro prices drop
and Greece experiences a boom in Tourism.
No doubt the
Greeks are weighing up all these options and will do what serves Greek
interest best in the end. Let’s glance at the dominant principles that will
guide the process in the days and weeks ahead.
On the
banking side, the concept of debt re-scheduling is unacceptable because it
would reduce the asset base of the banks and undermine their solvency. The
extension of debt and lowering of interest rates would overcome that problem,
but it is paramount that the debt be repaid eventually, in a manner that an
impoverished Greece can bear. The sell-off of state-owned assets will reduce
state revenues and likely cause a tremendous amount of employment cutting (as
the operations are made profitable) which will exacerbate the situation. The
severity of a new debt package will hurt Greece and ensure that its economic
woes last for up to a generation.
On the Greek
side the principles of democracy demand that Greek populations act in the
interest of the voting public. This means that they must assess whether the
solutions are acceptable to the Greek public. If they lead to the
nation’s impoverishment for a generation then the Greek public will not
accept them. A pragmatic assessment of the worst of the two situations must
be made, an onerous set of repayments, or The loss of financial credibility in the E.U. and the ejection of
Greece from the E.U. (might be the lesser evil)
Such an
isolation of the country may raise employment and improve tourism just as
sanctions in relatively developed nations often produce a boom. Whatever the
outcome you can be sure that politicians will follow voter’s first,
ahead of banking requirements.
Whatever
happens, it will prove very bad for the E.U. and the euro. Would you accept
their debt as collateral? Unlikely! What’s worse is that any attempt to
seize Greek assets without their approval may see Greece take itself out of
the Eurozone. Would the E.U. actually invade to
take Greek assets in payment of unpaid debts? A write-off of a good portion
of what’s owed may be a disaster, but it may well be the only option
left.
This may well
prove to be a battle of ‘bankers’ against democracy!
Greek Gold
Of critical interest
to the gold markets is the sight of Greek gold. Greece currently owns 111.5 tonnes of gold in its reserves [79.3% of its reserves]
which can be taken out of its reach and into the hands of creditors. The sale
of its government-owned assets to private hands under the pressure of
distressed finances may well not achieve anywhere near their value. Would the
Greek government pay the proceeds across to creditors immediately? Their gold
has far more value than its current market price.
Already gone?
But has it
already been used as collateral in a Bank of International Settlement deal
where it was swapped for foreign currencies? Last year the B.I.S. undertook many
gold/currency swaps in mysterious, undisclosed situations. Were they tied to
the bailouts? There will be no more devastating a blow to Greece’s
financial credibility than a disclosure that the gold has already gone.
It’s equivalent to the family jewels being sold off. And that is
gold’s value, not its market price!
The current
gold price is irrelevant to the repayment of debt. 111.5 tonnes
is worth only $5.5 billion, which barely scratches the surface of
Greece’s $350 billion debt. In a situation where monetary values are
collapsing (the U.N. has just issued a report in which they state their fears
of a U.S. dollar collapse) the gold price will leap to levels where national
debt becomes relatively easy to repay and certainly worth all the promises a
government can make at that time. Gold in extreme situations adds
considerable credibility and value to any debt situations, way beyond its
market price.
If the gold
is there, then Greece would feel that it is the one asset which they can use
when all credibility is lost. That’s why central banks hold so much
gold in the first place! If Greece were to leave the Eurozone
then Greece might have a chance, with their gold, to transition into a more
prosperous country.
Other Countries in Distress
A look at the
other debt-distressed nations that have received a bailout or may want a
bailout…
v Ireland has only 6 tonnes
of gold in its reserves, which (in current prices) is worth only $296
million. Ireland needs far more to solve its debt problems. The gold would be
symbolic of the nation’s family jewels. The cleverest move Ireland has
made was to insist on its low Corporation Taxes being maintained because this
will allow much higher revenues to be achieved.
v Portugal is in a different category. It has
382.5 tonnes of gold in its reserves which has a
current market value of $18.9 billion, which would make a significant
contribution to their debt situation.
v Spain has 281.6 tonnes,
whose value at current prices is worth $13.9 billion which again would make a
significant contribution to its debt repayment.
v Belgium has 227.5 tonnes
with a current market value of $11.2 billion.
v The U.K. has 310.3 tonnes
of gold remaining in its vaults. This is worth $15.3 billion.
v Italy which has just come under the
ratings agency’s spotlight holds 2,541.8 tonnes
of gold in its reserves. This is worth $121 billion at current values.
v With the U.N. placing the U.S. dollar in
the potential collapse category a glance at the published level of gold
reserves shows that it holds 8,133.5 tonnes of
gold, worth $4.01 trillion at current prices.
v What if the crisis spread and the E.U.
gold reserves at the E.C.B. came under threat? Its gold is 502.1 tonnes valued at today’s prices at $24.78 billion.
Having showed
these figures to you, we must stress that such gold reserves will only be
used if there are no alternatives. It is a last resort asset, which when gone
leaves the nation (almost) out of the international arena and in an (almost)
isolated position. In some cases this may prove a good thing. An extreme
example of this was seen when Rhodesia had international sanctions placed
against it. It thrived, as all the imports had to be substituted for the
local equivalents. South Africa, in the face of sanctions, also thrived. So
you can be sure that some nations will be tempted to default rather than
sacrifice their gold reserves.
As we said
above, they may well have been pledged already via the gold/currency swaps
last year and the current acceptance of gold as collateral is simply
preparing the way for the publication of deals after the event.
Julian
D. W. Phillips
Gold/Silver
Forecaster – Global Watch
GoldForecaster.com
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